Building a 21st century power sector

Credit: EU

We asked a panel of experts for their views on some of the biggest issues facing the European power sector now and in the future

Liberalization, renewables and evolution towards a single power market have all presented strategic challenges to the European power sector.

Meanwhile, utilities face dramatic upheaval as change sweeps across the European industry and the integration of renewables gains pace. Ahead of POWER-GEN Europe 2014 in Cologne on 3-5 June, we asked members of POWER-GEN Europe’s Advisory Board some of the key questions.

The board members were:

  • David Porter, senior advisor to the global energy team at Navigant;
  • Simon Hobday, partner at Pinsent Masons;
  • Tim Vink, director of regulatory affairs at Honeywell EMEA;
  • Philippe Paelinck, vice-president of portfolio and strategic positioning at Alstom;
  • Risto Paldanius, director of business Development at Wärtsilä;
  • Dr Franco Rosatelli, chief technology officer at Ansaldo Energia;
  • Dr Tamer Turner, chief executive of Yildirim Energy Holding.

PEi: Over the past 30 years European governments have been deregulating and privatizing energy markets, separating generation, transmission and distribution. What have been the notable successes and challenges so far?

David Porter à‚  David Porter: Deregulation and privatization have ensured competition in power generation and supply and delivered value to taxpayers, made capital investment more efficient, and provided greater choice and lower wholesale and retail prices. However, transparency and, more importantly, volatility in prices continues to give consumers cause for concern.

Simon Hobday: One of the major benefits of deregulation has been the introduction of transparency around cost and, through liberalization and privatization, a focus on the efficient use of capital in the areas that are competitive. This has also ensured prices are lower than they otherwise would have been, by allowing greater efficiency.

Tim Vink: The biggest challenge has been to develop and implement a proper regulatory framework to ensure reliable supply is guaranteed. Volatility in wholesale electricity prices means new investment will require a risk premium that did not exist before. Possibly the most neglected issue is the role of demand response systems. What happens beyond the meter is just as important as the supply to it.

Franco Rosatelli: The liberalization of energy markets in Europe and the separation of generation, transmission and distribution in most countries have played a crucial role in increasing the efficiency of energy systems for the benefit of industrial users and consumers alike. New players have strengthened their presence in the energy markets, endowed with higher efficiency, a greater propensity for investment, and greater generation capacity compared with former monopoly players.

Philippe Paelinck à‚  Philippe Paelinck: The creation of a single European electricity market has been moving in a positive direction. With the EU Electricity Liberalization Directive agreed by all Member States forming the framework of EU energy policy, the overarching goal is for consumers to benefit from an internal market governed by co-ordinated rules – for the implementation of renewables and development of the electricity network. A market-oriented European energy system also aims to make the most of different types of power generation and to optimize the costs associated with managing, maintaining and evolving the grid infrastructure.
Risto Paldanius à‚  Risto Paldanius: Over the last five to 10 years, there has been large reformation of the European power system, as a result of the successful promotion of renewable energy sources. However, this has resulted in some undesired side effects. One of these is that an ‘old commodity’ product, electricity, has been turned into a highly volatile market product where production costs and revenues are not necessarily aligned. Stable rates of return and flat consumer rates are just not there anymore. Yet, investments in ‘basic infrastructure’ such as power plants are 20-year commitments, and are hard to make bankable if the planning horizon has shrunk to one to two years. This has led to security of supply concerns, both in the short term balancing time frames to deal with the intermittent character of RES, and in the longer term around capacity adequacy.

Tamer Turna: The power generation market has grown in tandem with privatization. As such, the market-oriented model has so far proved very successful. But a completely deregulated structure has not yet been achieved, and neither has complete political independence of the energy market regulatory authorities. Public opinion and subvention schemes have enabled creation of the market for renewables. Given this has mainly been sustained via regulated tariffs, the greatest challenge to the renewables model lies ahead with the realization of a fully liberalized market.

PEi: How will the evolution of Germany’s energy market influence that of other European markets, and what lessons have been learned?

Simon Hobday: In terms of the electrical system within Germany, a large number of wind farms have been established across northern coastal areas, placing increasing strain on the transmission systems and the ‘bootstrap’ corridors either side. This strain is due to the way in which the physics of wind power generation works: where wind speed varies in a short period of time in northern Germany, the concentration of wind generation affects voltage control and grid stability, with knock-on effects on and fluctuations in pricing. Given the increasing interconnection of European power markets, this type of fluctuation doesn’t just affect Germany’s power market, but those of surrounding countries, because power prices interact with and flow across neighbouring countries and linked markets.

David Porter: Germany’s Energiewende, like many political decisions about energy, has had unintended consequences. The phasing-out of nuclear power and the huge commitment to intermittent sources of renewable energy has led Germany to rely heavily on coal-fired power generation to maintain electricity supply and more coal-fired plant is being built. That makes it harder to reduce emissions.

As the experience in Germany has clearly demonstrated, incentivizing weather-dependent renewables can displace the ‘on-demand’ conventional generation needed when wind and sunshine are not available.

A further lesson from the experience in Germany is that capacity is an issue when there is an increased level of intermittent energy provided via renewables. In the absence of large-scale storage, the more intermittent generation there is, the more backup capacity is needed. The role of an ‘energy-only’ market is being questioned because many energy companies argue that they cannot keep ‘on-demand’ plant available, or build new, if their running regime and income is going to be so unpredictable.

Tim Vink: Potentially the biggest impact may be that Germany becomes a net importer of power. That would require additional investment in transport and transmission infrastructure. The other concern is that, as the cost of power increases, it may affect the competitiveness of German industry. If anything, these developments show there is a need for a truly internal market for electricity.

PEi: How could utilities be compensated for providing the underlying base power required to ensure a more reliable source of energy – for example, is a capacity subsidy a good idea?

Tamer Turna: The capacity subsidy is a practical idea, ensuring return on investment and securing jobs. However, I would like to see only capacity generating technologies younger than 30 years being subsidized. Older plants should be decommissioned, as they have served their purpose (and earned their money), and this will provide room for more efficient stations.

Risto Paldanius: As mentioned, there are two challenges related to security of supply. We should differentiate between capacity, which means ensuring longer term adequacy and capability, and addressing the short-term flexibility requirements of the power system. A market-based approach that rewards flexible providers and promotes self-balancing can incentivize investment in flexibility. Flexible providers can also be used to provide backup.

Philippe Paelinck: To ensure grid stability in the future power market, renewables need to contribute to security of supply just as fossil fuel operators need to contribute to climate protection. This could be achieved by renewables supporting the efficiency of the overall system by being traded together with stable forms of generation – specifically in combination with efficient fossil fuel generation. The market would also need to factor in the cost of increased intermittency. The experience in Germany, however, has demonstrated that the incentives for renewables can be overgenerous and distort investment. The rules governing the internal market will have to be considered carefully, especially in a context of flat or even decreasing electricity demand.

The so-called capacity market is one of several potential solutions to this issue, but national initiatives would need to be closely coordinated at EU level to avoid another layer of complexity that could potentially further undermine the situation.

PEi: What are the key challenges in realizing greater interconnectivity, and what is more important: energy independence or unification?

David Porter: It is possible to have much greater levels of physical interconnectivity of power networks between nation states without it becoming a question of political unification. Even in a region of independent nation states, it is likely that greater levels of network interconnectivity between them would be desirable. Interconnectivity delivers resilience, and the diversification of energy sources consistent with the objective of national security. The EU, recognising the need for more cross-border interconnection to deliver a single electricity market, is encouraging this with financial support.

Simon Hobday: Interconnectivity comes down to a mixture of different issues. One is the physical interconnection: if you are looking to have a market that spans areas with limited connectivity between them, you can’t get the physical power flows to react to a market price signal over the wider area. A further issue is that legal and regulatory differences create barriers, as do technical standards. Barriers can also arise from localized vested interests, which can range from political and regulatory to commercial. These types of issues influence behaviour of individuals and entities in the sector, and hence that of the markets themselves. As such, interconnectivity, energy independence or unification all comes down to the same question: where is the line drawn on interconnectivity and independence? At the same time, any answer has both economic and political ramifications, with security of supply also coming into the equation.

PEi: While uncertainty in the market is nothing new, is change being forced too quickly on a system unprepared to deal with it?

Tamer Turna: Yes, I believe this to be the case. An evolution instead of a revolution would be more appropriate – especially as we now have a much better understanding of the types of problems to be expected. Policymakers have to be more realistic with regard to the technical, economic and social capacity of their market to absorb change.

Risto Paldanius: The basic structure for any market is a framework. This needs to be in place before we can expect players in the market to be able to cope with change. The market was not ready for the high penetration of renewable energy sources, because the existing framework does not support the new needs of the power system. While the rollout of renewable energy has been a great success, the legacy framework was not updated accordingly. There is an urgent need to build a framework to deal with the effect of RES.

Philippe Paelinck: Certainly the challenges that have to be addressed – namely competitive electricity, reduced environmental footprint and energy security – require urgent action. We don’t yet have all the tools in place to incentivize and deliver all the changes in investment needed, at the necessary pace.

Simon Hobday: Market uncertainty has been a given in the European power industry for as long as the private sector has been involved. Significant political uncertainty, however, is relatively new to the energy business, and is not only resulting in a degree of reluctance to invest, but raising a number of questions around political risk that many in the industry never expected to see in Europe.

A growing number of banks, for example, are now questioning the market basis on which to model investments and hence what will make worthwhile investments, with the whole mindset having changed because political uncertainty has altered the dynamics of the industry time and again over the last five or six years. Subsidies, for example, have been introduced, increased, reduced or even withdrawn with limited notice. There have also been numerous, often unpredictable changes of policy regarding the type and manner of generation incentivization.

So while market uncertainty is a given, and markets are adept at harnessing predictable change, difficulties have arisen in the past few years from political uncertainty and the framework within which the markets are meant to operate. Stakeholders in many cases aren’t clear whether they are going to be playing in the same game tomorrow as they are today, and with limited or no confidence in the business model being invested in, it is not surprising to see a reluctance to invest.

Tim Vink: I do not believe that it is the pace of change, but rather that change has been erratic.

The key challenge for stakeholders is to have a steady, long-term planning horizon. That can, and must, be fixed. The European Commission’s paper of last year, Delivering the internal electricity market and making the most of public intervention, is an excellent starting point.

David Porter: It is worth distinguishing between two types of change: those which are evolutionary (and would have likely happened anyway regardless of policy) and those which are transformational (driven by policy to meet external factors such as national or political commitments to CO2 reduction).

It really depends on how quickly you want the outputs that the changes will deliver. This is a matter for government policy, which has to balance the desirability of the outputs such as security, decarbonization and affordability, with risk, efficient delivery of infrastructure and best value for money.

PEi: Where does the investment in the future European grid need to come from (for example, pension funds)?

Tamer Turna: I believe funding a ‘market central grid’ is the only solution to overcome the challenge of integrating intermittent (non-time and -capacity reliable) renewable energy sources such as wind and solar. We already see this in some of the liberal power markets, such as Turkey, where the transmission grid is not privatized and remains under governmental control and funding.

In more liberalized markets, the transmission system would be a solid investment for investors such as pension funds due to the fact that, technically, it is a monopolistic mode of operation and therefore a relatively secure investment that could be set on a fair long-term return.

Philippe Paelinck: The European power market is being held back by several recurring questions around regulation, scalability and replicability. Investment in the new grid will require new business models, and these will emerge from the demonstrators and pilot projects around demand response, storage, and distribution control currently underway.

Risto Paldanius: A well-developed grid is required to transport electricity to the areas where it is valued the most, i.e., developing the grid alone is not enough to deal with the challenges of flexibility and capacity adequacy. In addition, electricity markets that signal the value of electricity across different timescales (short-term balancing markets, spot markets, forward markets) will provide the incentives for investment in capacity and in the grid. If the incentives are there, investment will come forward.

PEi: What role should governments play (and to what extent) in protecting the future of the utility companies?

Philippe Paelinck: Governments can help by providing long-term and stable regulation that creates a level playing field for all decarbonized power generation solutions. Regulations must be based on the true cost of dependable electricity supply. They should also provide visibility on renewable penetration goals, efficiency improvements and carbon reduction objectives. Furthermore, politicians must look to redress the EU-ETS market, which is currently failing to provide a meaningful CO2 price.

Risto Paldanius: To drive environmentally friendly electricity production, different governmental-level mechanisms have been created across the EU.

These have directed production and consumers towards more CO2-neutral production and consumption. But at the same time, one could see these as an intervention to liberalized electricity markets. Ideally, all generation technologies should be able to compete based on their own merits but, of course, any technology can be successful if the right support mechanisms are applied. Governments should create a market-based framework to incentivize the investments needed to deal with the challenges introduced to the system by the massive increase in renewable energy sources (as a result of government policy).

Tamer Turna: Thanks to democracy, public opinion has the ability to change energy policies in intervals of three to five years, whereas payback periods for investments in energy plant and infrastructure are five to 15 years – and sometimes even longer. Regulatory uncertainty harms the investment climate.

Thus, only technically efficient solutions, and utilities with long-term financial viability potential, should be protected.

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